Explainer: India’s GAAR or General Anti-Avoidance Rules
Investors in India are nervous as it looks like the government aims to go ahead with plans to close more tax loopholes through a new set of General Anti-Avoidance Rules, or GAAR.
While the new rules were slated to come into effect in April, many investors and executives had expected the government to postpone the rules. On Friday, however, Minister of State for Finance Nirmala Sitharaman reportedly said that the rules may be implemented as planned, triggering concern that many companies are not ready for what the new tax regime would require.
Here’s an explainer on what the fuss is about:
GAAR is basically a set of rules designed to give Indian authorities the right to scrutinize and tax transactions which they believe are structured solely to avoid taxes. The rules would be applicable to all taxpayers.
Throughout the world, companies often structure their businesses and investments in ways that saves them taxes. Many large U.S. companies, for instance, park their profits outside the country so that they don’t have to pay a higher U.S. corporate tax rate.
If GAAR starts in India, any transaction that carries a tax benefit could be questioned. The taxman may potentially want to know whether the transaction was done in the normal course of business or conducted simply with an intention to avoid taxes.
Some of the hardest hit by the new rules could be money managers who invest in India via tax havens like Mauritius. Since Mauritius has a double-tax avoidance treaty with India, investors who trade Indian securities through their Mauritius units don’t have to pay India’s high capital-gains tax.
If GAAR comes into place, it would override the tax treaty and some investors that created shell companies in Mauritius will be exposed to paying more taxes.
“The benefits of favorable jurisdictions would be taken away under GAAR,” said Krishan Malhotra, head of taxation at Indian law firm Amarchand & Mangaldas & Suresh A. Shroff & Co.
To avoid double taxation, the investment company will have to show it has “commercial substance” in the country it is trading through. This could involve showing that the company has a large staff in Mauritius or that it conducts business meetings there and makes investment decisions from there.
Since a lot of foreign institutional investment into Indian stocks comes via Mauritius-based entities, stock investors have become worried about the new rules, dragging the S&P BSE Sensex lower by around 1% in the two trading sessions through Monday.
Though anti-avoidance rules exist in various other countries, including Germany, France and Canada, tax experts say that there is some concern among investors that Indian tax officials could get heavy handed about implementing GAAR.
“They are scared as to how will the tax office interpret it,” said Girish Vanvari, tax partner at KPMG in Mumbai. “Will it just be another tool for them to be harassed?”
Tax experts note that GAAR provisions can be applied to practically any transaction that leads to a tax saving. So if an Indian company restructures its business units in a way that leads to tax savings, Indian tax officials could potentially question whether the restructuring was done simply to avoid taxes.
“There should be a framework laid down” on how GAAR will be implemented, said Ketan Dalal, Mumbai-based senior tax partner at PricewaterhouseCoopers India.
